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Wednesday, July 24, 2013

Debt problems in Europe extend beyond the headline figures

On Monday, Eurostat released its latest figures on public debt to GDP, which soared to a record of 92.2% in the eurozone in the first quarter of this year. Of all the eurozone members, only Germany and Estonia were able to reduce their debt levels in the first three months of 2013, while in total five eurozone members had debt-to-GDP over 100%.

High government debt is obviously a well-covered issue and a well-known problem in the eurozone. However, the debt problems extend well beyond this simple figure - we've touched on this previously, when looking at the level of financial sector debt and the need for a eurozone banking union. Another potentially interesting aspect of the debt problems relates to what is known as 'implicit debt'. This is an estimate of the future debt which states will accrue including contingent liabilities such as pension payments and welfare payments (many of which are, at this point, unfunded). 

In that vein, we thought it would be worth looking back at an interesting study produced by German think tank Stiftung Marktwirtschaft in coordination with academics at the University of Freiburg at the end of 2012. They've had a go at calculating the level of 'implicit debt' in the EU and what it means for debt sustainability. The results are laid out in the table below.

('Implicit debt' is calculated using data on future GDP growth as well as on the long-run change in age-dependent expenditure, using the European Commission’s reports on ageing, all done assuming no policy changes and put into 'present value' terms).

As with any such calculations, there are numerous assumptions and we must be wary of drawing grand conclusions, but the results provide some interesting points nonetheless. At the bottom of the debt sustainability ladder, we see the usual suspects such as Greece, Cyprus, Spain and Ireland (raising some questions about how effectively it is really recovering from its crisis). Slovenia, a country which we warned may be in line for a bailout, also finds itself in trouble by this metric. Surprisingly, Luxembourg fares very badly; the authors suggest this is down to its "generous" pension system which has not been overhauled to deal with future demographic developments.

It may also surprise many that Italy ends up top of the table. The authors suggest that this is due to the fact that the country "expects only a small rise in age-dependent expenditures as a proportion of GDP." Italy admittedly made quite an effort already in reforming its pension system (in the 1990s and more recently under Mario Monti's technocratic government) but this outcome does seem fairly optimistic, not least because it is reliant on Italy maintaining a long term growth level of close to 2% per year.

All that said, another study, by Société Générale, on the topic of "unfunded liabilities" relating to pension and welfare costs, places Italy's at 364% debt of GDP suggesting it is better off than France (549%) or Germany (418%). Similarly, by the SocGen method, Spain would only have a burden of 244% to GDP, showing that a lot depends on the precise calculation and what is included. Perhaps a bit worryingly, the UK is doing worse than most eurozone countries in both calculations.

According to Johan Van Overtveldt, the editor-in-chief of Belgian magazine Trends who flagged up these results, "These figures are taken very seriously by the ECB". With regards to Italy, he warns that "an increased interest rate or a continuing recession (or a combination of the two) can quickly and drastically overturn this positive image".

In any case, these figures provide some added depth to the on-going debt issues in Europe and debatedly provide a slightly more complete picture than the simple headline debt to GDP figures. As we have noted before, though, this is simply one aspect of the varied and complex eurozone crisis which extends beyond just government debt to the banking sector and international competitiveness (to name but a few areas).


Rik said...

It is a huge probelm but the reporting looks crap.
Italy with NEGATIVE future not funded obligations simply totally unrealistic to start with.
Doesnot agree with decently looking US calculations. Some Europeans are lower while the US has less of a demographic problem and less welfarestate. Simply doesnot make sense.
One Italy at negative 123% while the other puts it at 364% positve also looks pretty strange.

Clearly a huge problem. As this crisis shows cuts are nearly impossible to sell. So might require a bankruptcy to be able to do that. And on the other hand cuts are unavoidable. Markets will not accept 400-500% debt of hardly growing economies. Long before that it will be end of story.

And taxrates look to be at the max. And already with huge deficits. While rule of thumb aging will lead to 1/2% structural drop in growth (next to the new normal) and raise government expenditure with another 1/2% annually per year and every year. All until 2040-2050 roughly.
Hard to see that the present youth will bring that up and even if they could would be willing to do that. As it would become increasingly unlikely they themselves would benefit from eg a pension and cheap healthcare when they are old.
High rates are one of the reasons several countries are uncompetitive.
Nearly all high taxes end up in prices in the end and there usually become very sticky, which makes corrections nearly impossible as said.

jon livesey said...

Sorry, but this entire piece is based on fallacies and misconceptions.

For example, the notion of "implicit debt" is a nonsense. State pensions and welfare payments are not paid out of future debt, but out of future tax revenues.

There is no "endowment" out of which pensions and welfare payments are made, so there is nothing "unfunded" and no "implicit debt".

All that will happen is that in the future, those who are working will pay taxes, out of which pensions and welfare payments will be made to those who are not working, *exactly* as happens today.

To say we have a "debt" today because tax revenue in the future will be used to pay pensions and welfare payments in the future is completely meaningless.

It is as meaningless as it would be to say that in 1980 or 1990 the UK had a huge "implicit debt" representing pensions and welfare payments being made today.

Anonymous said...

So it is only refering to the eussr not to Europe, why is it that people make the mistake of refering to this body as the whole of europe. The Debt problems are down to two reasons, bad governance by the political failures at the commission and the euro, which is at to low a level for Germany but to high a level for the other economies so it is the worst of all worlds and creating the situation.

jon livesey said...

If you want to know the future evolution of European fiscal affairs, forget things like "implicit debt" and simply look at demographics.

In any economy, at a given moment, those who are working contribute some of their earnings to pay state pensions and welfare to those who are not working.

So the ratio between working and non-working is the key issue. Those who are not working need to consume some portion of the output generated by those who are working, and the exact details of the accounting really does not matter.

If you want to know which EU countries will be well off in 30 years and which not, just look at the evolution of their demographics over the same period.

Countries that encourage immigration will be in a good spot in 30 years, and those which discourage it will be hurting.

Rik said...

Implicit debt is very relevant, but may be not as i8mplicit debt. As eg this crisis has shown.
For several reasons eg:
-You mention that is is paid from current taxes. The problem however is that that roughly half the EZ at this moment is not able to do that and has to borrow to fill the gap.
-Similar if for competition reasons taxes would have to be reduced. Simply impossible as it looks now.
-Aging makes this problem much worse most EU countries are now at the point where costs of this stuff will only rise because of aging. In optimistic scenarios in 2030-2040 things will stabilise with 10-15% (probably closer to the 15) of GDP in average more necessary to pay for more pensions and the higher healthcare cost related to an aging population. Combined with lower tax revenue as the percentage of taxpayers will decrease enormously. Not even to mention the quality (earning/tax paying capacity) of those tax payers).
Looks like the precent just below 50% overall taxrate is about the max that markets and populations accept add 15% and you drive against the wall as simple as that. And the present rate seems effectively already too high as a lot of countries haver to overborrow to finance the gap. Combined with much cheaper competition just around the corner not a great prospect.
Simply looks like the thing will have collapsed long before we are in say 2040. So not too far from now. And with all those unfunded pensioners having a huge problem.